Gauging The Potash Fallout

On July 30th, Uralkali, Russia's biggest potash fertilizer producer, withdrew from the Russo-Belarusian potash cartel BPC, thereby breaking up the BPC. Fed up with Belarus allowing Belaruskali to sell potash independently, most likely to exceed sales quotas set by the BPC, Uralkali has decided to go it on its own. Think of this as a major member of OPEC leaving that organization and you might get an idea of what happened here. This will shake up the potash supply dynamic because it brought down one of the world's two major "marketing organizations." (The other cartel is Canadian.)

This is important because the two potash cartels previously represented 65% of global production of this fairly abundant mineral's supply. This control set prices high and made for lucrative contracts with potash-hungry developing countries.

This article will look at the potential fallout from this move. It will look at the overall supply and demand situation going forward as well as the winners and losers from this event. Much of the damage has already been done, however: Major producers such as Agrium (NYSE:AGU) and Mosaic (NYSE:MOS) have seen their stocks tumble. PotashCorp (NYSE:POT), which has the highest potash concentration, has been hit the hardest. It's stock at one point had lost 30%.

Relax, It's Still An Oligopoly

While the market's visceral reaction may have been a panic, this move may not be a game-changer, after all. Previous to the BPC breakup, 65% of global capacity was from BPC and Canpotex, the Canadian cartel. Post breakup, 50% of global capacity is still in the hands of the big two: Canpotex and Uralkali Trading. Potash capacity will still be concentrated in the hands of the few.

The bigger issue is whether this breakup will result in a move from fixed pricing to cost-based pricing. Will potash prices continue to be fixed by the big guys or will it finally be market-priced? We aren't really sure just yet, but no matter what the outcome, it seems potash prices per ton will be down for at least the intermediate term.

The Winners

China and India

If potash prices are going to stay below $500 per ton, the two biggest net importers are the most obvious benefactors. There's no doubt both of these countries will be bargaining hard to squeeze more price out of the big suppliers and using this breakup as leverage.

Farmers & Consumers

Farmers are the next obvious benefactor. Lower fertilizer prices will mean better margins for farmers. While there are several types of fertilizers out there, potash is considered the highest quality of them. Lower prices could make potash more affordable to more farmers.

This year commodities have been broadly falling with only a few exceptions. Until now, potash has been one of those exceptions. Consumers could very well see lower food prices in coming months. This depends on how much margin farmers can take, but lower fertilizer prices can only help consumers.

The Losers

Canada

Canada is the world's largest potash producer. The province of Saskatchewan in particular is tied to potash. Saskatchewan expects $519.9 million in royalties in fiscal 2013-14, which is well higher than the previous year. That number is now certainly too high. Economists estimate that a double-digit drop in potash revenues will lead to zero economic growth in the province. But fallout will not be limited to just Saskatchewan. Already the drop in fertilizer prices has affected the Canadian dollar negatively.

Belaruskali

Some believe that Uralkali's exit from BPC is just a power play to bring the Belarusian producer in line. According to the CEO of Uralkali, however, the whole breakup was "unavoidable."

I don't believe this cartel will be reforming anytime too soon. Everything in Baumgertener's body language and tone of voice in this video says this breakup is indefinite. Perhaps Uralkali does not think this will be a game-changer in the long run. Belaruskali has lost its long-term access to this powerful "marketing organization."

Big Producers

The big producers such as PotashCorp, Agrium, Mosaic and especially Uralkali will suffer from lower prices. Their stocks have already been affected. Some, however, believe it will not be such a big deal for any of them.

And discouraging new entrants, some believe, is the real reason this breakup happened. Attracted by very high EBITDA margins brought in by the established potash producers, global miners have been clamoring to get in on the action. Uralkali leaving the BPC cartel has resulted in a much lower potash price. This, in turn, eats away greatly at those margins the new players want to get in on. Is this cartel breakup a "shot across the bow?" The barriers of entry sure look higher right now.

New Entrants

The biggest new entrant into potash is easily BHP Billiton (NYSE:BHP). In 2010, they began construction on a new mine in Saskatchewan that would be the single largest potash mine in the world. Oversupply has already called into question the Jansen mine. According to commodity specialist Patricia Mohr at the Bank of Nova Scotia, the breakup "almost certainly means the Jansen mine is going to be delayed or deferred."

This $14 billion project will take a big bite out of BHP if delayed and deferred. It would also add to an already long list of questionable projects and acquisitions by BHP, including the Olympic Dam deferment, the money-losing Petrohawk acquisition and failed acquisition of PotashCorp, itself. This does not bode well for BHP.

Conclusion

Is the BPC's breakup a game changer? Only in a few ways. New entrants are going to have to rethink their stance. But I don't believe that the cost-base pricing of potash is going to happen. Price wars benefit none of the producers, and half of supply is still concentrated in two powerful organizations. These lower prices will, however, serve to raise the barriers of entry, strengthening the established players.

The primary risk that keeps me cautious and out of the fertilizer industry are India and China. While economics still benefit the existing producers, the Chinese and Indian motive for food self-sufficiency is extra economic. Their efforts to develop new potash capacity and invest heavily could still tip the balance of supply and I will cover this in my next article.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.